I’ve been thinking a lot about what’s going to happen to the economy so I can prepare for it. The idea that it’s possible to see at least broadly what might happen is alluring. Generally, the economy behaves the way it has in the past, and it’s safe to assume that whatever has worked well in the past will continue to work well. But there are periods of time that are paradigm shifts where all the old rules go out the window, like the oil crisis of the 1970’s and the Great Depression of the 1930’s. It feels like we are now in one of those paradigm shifts. We had a world-wide pandemic that resulted in the shock of shutting down the economy everywhere around the world, then another shock of bringing it back online. Almost immediately after that, we saw the World War II-like invasion of Ukraine that is becoming a Cold War with Russia. And now it looks like a Cold War with China is developing as well.
It would be a good time to figure out where this is taking us, the rules of the old order may not hold true in the new one. Is there some way to forecast what this will do to the stock market and the economy so I can invest in the right place at the right time?
But forecasting is tricky. First of all, I have no special information everyone else doesn’t already have. I only know things everyone else knows, or could know. Prices of stocks and bonds and other investments already reflect things everyone knows, or at least the things that most investors believe. One way to invest is to just acknowledge that I don’t know anything special or unique and just throw my hat in with the wisdom of the crowds. And the simplest, cheapest, way to do that is to invest in index funds that track the S&P 500 or some similar index. That won’t always go up, and will sometimes go way down. But historically, measured over long periods of time, it has always gone higher.
An alternative would be to try to take advantage when I think the wisdom of the crowds might be missing something important, or that they are a little too complacent. Buying when everyone else is selling, or selling when everyone else is buying could work out really well or be a complete mistake. I read an article by Howard Marks about forecasting that was really eye opening. Making money from taking a contrarian view means:
- I have to correctly see something that is coming.
- It has to be something everyone else doesn’t see or appreciate.
- My forecast for the future has dozens or hundreds of implicit assumptions, and if any of those assumption is wrong that can have a huge impact on the final outcome.
- People will react to the changes in ways that are impossible to foresee, and that changed behavior can mitigate or even reverse the expected outcome.
- It can take much longer for things to happen than I expected, then happen faster than I thought they would, but I have to have a pretty accurate idea of when things will happen so I don’t act too soon or too late.
- I also have to have a pretty accurate idea of when the contrarian idea is going to quit working and revert back to aligning with the wisdom of the crowds.
Getting all that right is a pretty big bar, and not very likely. Everyone is wrong sometimes, so believing something that is not the general wisdom could be right. But, how can I know something nobody else knows? I probably can't. At best I can know what everyone knows but disagree with the common wisdom about what it means or how soon it will matter or change.
Most forecasts are extrapolated from past results, and things don't change much most of the time, so most of the time the wisdom of crowds is right. But when there's a paradigm shift, forecasts based on things that worked in the past no longer work. So the only time when it might be safe to make a contrarian call is in those paradigm shifts. And I think a world wide pandemic and economic shutdown and reopening, a war in Europe, world wide efforts to localize and re-shore production, and the transformation of the world's energy system, are enough changes to result in a significant, world-wide, paradigm shift.